BOJ seen moving towards exit, data shows recovery

The Bank of Japan is set to map out an exit from its five-year experiment with an unprecedented, ultra-easy monetary policy later this week after data showing a solid rise in consumer prices and a sustained economic recovery.

Odds appeared even for the BOJ to make the much-awaited move at the two-day meeting starting on Wednesday, as central bankers are not yet in agreement on what to do after dropping the "quantitative easing" policy of flooding the banking system with cash.

But financial markets and central bankers said they were gearing for a near-final debate on an exit policy and that change would likely come in April if not this week.

"The economy looks strong, and the anticipation is so high, the only question is whether they can agree on details," said Seiji Adachi, senior economist at Deutsche Securities.

"The market has already factored in a change and there isn't much political opposition, so I'd bet on a move this week."

The BOJ has promised to continuing quantitative easing, which is aimed at spurring business activity and bolstering prices, until it is sure deflation is over for good.

Data last Friday showed a 0.5 per cent year-on-year rise in the core consumer price index for January, further recovering from a seven-year downtrend that had prompted the BOJ to adopt its quantitative easing policy in March 2001.

The data, together with widespread media reports saying change was imminent, moved forward expectations which previously had focused on a move in late April.

A Reuters poll on Friday showed 15 out of 31 market players expected the BOJ to end quantitative easing this week. Another 14 forecast a shift on April 11, and two saw a move on April 28.

BOJ Governor Toshihiko Fukui kept his cards close to his chest yesterday.

"As to our promise to maintain our policy until consumer prices stabilise above zero, we will not hold any preconceptions going into the monetary policy meeting and we will decide in a cool-headed and objective manner," he told a parliamentary committee. Most say the likely scenario is for the BOJ to announce that it will end quantitative easing and mop up excess funds by gradually lowering the volume of current account deposits from the 30-35 trillion yen ($260-300 billion) level it targets now.

The BOJ is expected to keep short-term rates near zero percent until later in the year when the core CPI shows more significant gains, and to keep buying 1.2 trillion yen ($10 billion) in Japanese government bonds (JGBs) a month for a while.

The main sticking point, however, is how the BOJ will guide market expectations under a new policy regime, such as whether it will adopt an inflation target or some vaguer yardstick.

"Whether or not the BOJ moves this week depends on whether members can agree on details of how to communicate with markets after an exit," said Yuichi Kodama, an economist at Meiji Yasuda Life Insurance. Mr Kodama said the BOJ should adopt an inflation target to boost transparency, but most analysts said the BOJ was unlikely to set any numerical target that could limit its flexibility.

"I think they won't want to have their hands tied," Deutsche's Adachi said. "They will probably opt for something in the form of statements, instead of numbers."

Either way, analysts say financial markets are ready for a change. Yields on two- and five-year JGBs have surged to five-year highs over the last few weeks.

Yesterday, the two-year yield climbed two basis points to 0.520 per cent, matching a high hit last week, while the five-year yield rose two basis points to 1.090 per cent. The 10-year yield was up 1.5 basis points at 1.630 percent.

A government survey yesterday showing firm capital spending added to anticipation of a change in BOJ policy. Corporate spending rose 9.5 per cent year on year in October-December, which was weaker than expected, but still marked the 11th straight quarter of gains accompanied by strong sales and profit figures.

Given such upbeat economic data, few government officials have openly opposed a BOJ move, but the Finance Ministry is concerned about the prospect of higher long-term rates, which would raise the cost of repaying Japan's massive public debt.

Prime Minister Junichiro Koizumi called on the BOJ to exercise prudence, saying the government and BOJ could not afford to let the economy sink back into deflation, although he added that the final decision was up to the BOJ.